Rising commodity prices presage return to economic growth

The Commodity Research Bureau (CRB) publishes the most widely followed index of commodity prices. It fell sharply beginning in early 2001. The index has since risen steadily and now stands at about 239. Based on current figures, the U.S. recession may well be past and America is in the midst of an upturn. [See the Figure.] http://www.ncpa.org/edo/bb/2003/images/bb012703.gif

In short, the economy went through a period of deflation, the opposite of inflation. That is, falling instead of rising prices.

This fact was not evident to most people because the Consumer Price Index (CPI) lags far behind the CRB's index and because the CPI is heavily weighted toward finished goods and services, rather than raw commodities.

However, the same fundamental forces that drive basic commodity prices eventually impact on the general price level and these forces are what determine the overall level of economic activity.

If businesses cannot raise prices and must continually cut them, then profits are going to suffer. This forces cutbacks and reduced investment. The result is a recession.

Therefore, the upswing that we have seen in commodity prices is a strong sign of a turnaround – but of course, with a lag.

As prices rise, profitability returns, leading to new investment and the rehiring of laid-off workers.

As aggregate incomes rise, sales increase further, leading to economic expansion.

So, for a time, rising prices are good-indeed, necessary for the economy to grow, but the Federal Reserve must be diligent to ensure that a modest and beneficial reflation does not turn into inflation.

The return of "pricing power" is a strong sign that 2003 will be a good year for the stock market and the economy. But it may still take a while before this becomes generally apparent.

Source: Bruce Bartlett (senior fellow), National Centre for Policy Analysis, January 27, 2003.

For text http://www.ncpa.org/edo/bb/2003/bb012703.html
For more on Economic Issues (Inflation & Prices) http://www.ncpa.org/iss/eco/

FMF Policy Bulletin\28 January 2003